Cement sector on move: IIFL

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Cement sector on move: IIFL

IIFL has come out with its report on cement sector.

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RELATED NEWS Accumulate Maruti Suzuki; target of Rs 1313: PLilladher Buy Ahmednagar Forgings; target of Rs 160: Sunidhi Sec Buy ICICI Bank; target of Rs 910: IIFL

IIFL has come out with its report on cement sector.

We believe that the domestic cement cycle is at a trough; from here on all key industry metrics should improve, particularly for players in the eastern, northern and western regions. We estimate capacity utilisation levels in these three regions to rise to 85-93% by FY14 (up 6-8% from current levels), aiding the return of pricing power. Incremental demand will likely outpace fresh capacity additions, driven by a mean reversion in demand growth and a slowdown in new supply. Ambuja Cements, Shree Cement and UltraTech Cement are best positioned to capitalise on the coming cyclical upturn and are our top BUYs."

Capacity utilisation - bottoming out: In contrast to the FY08-11 period when capacity additions outpaced incremental demand by 120%, we believe that during FY11-14, incremental demand will rise faster than new supply. India's cement demand has historically grown at 1.2x real GDP growth. Over the past two years, cement demand has grown at just 6% YoY and a likely reversion to mean will drive a pick-up in growth rates. Incremental capacity addition in the next three years, compared with FY08-11, will almost halve to 54m tonnes. We expect utilisation levels to bottom out in the current quarter and gradually but sustainably improve from here on.

Pricing power - coming back: Rising capacity utilisation, improving competitive environment (due to a fall in the number of new entrants) and better industry discipline will aid the return of pricing power, in our view. However, the gains will be uneven across regions. While producers in the eastern, northern and western regions will gain the most, those in the south will likely see no improvement in pricing power. For the three regions with a favourable swing, we estimate prices to go up by 8-9% and correspondingly, Ebidta margins to rise 200-300bps by FY14. We believe consensus estimates will see sustained upgrades.

Playing the upturn: We estimate earnings of IIFL's coverage universe to rise by 18% Cagr over FY11-14, in contrast to a 6% compounded decline during FY08-11. The three best proxies to play the upturn in the cement cycle are: Ambuja Cements (ACL), UltraTech Cement (UCL) and Shree Cements (SCL). ACL derives 90% of its sales from the regions that have the most favourable swing; UCL derives 65% of its sales and SCL 72% of its sales from these regions. Our current earnings estimates suggest a 16-18% EPS Cagr between FY11-14 for our top BUYs. ACC and Grasim are less leveraged to the cyclical upturn and we rate them as ADDs.

We expect ACC to continue to show improved volume growth, owing to stabilisation of new capacities that commenced in the past year in the southern and western regions. ACC, a pan-India cement player with a balanced regional mix and capacity of 30mtpa will partially benefit from utilisation improvement in the eastern, northern and western regions; however, earnings would be volatile, as ~45% of its volumes are from the central and southern regions, where utilisation is unfavourable. ACC is trading at a reasonable 8.1x CY12ii EV/Ebitda. We recommend ADD on the stock.

We recommend BUY on Ambuja Cements (ACL), as the company is likely to be the biggest beneficiary of improvement in utilisation in the eastern, northern and western markets. The company expanded clinker and cement capacities in the northern and eastern regions in 4QCY09; new capacities stabilised in the past year and likely improvement in utilisation in these two regions should drive volume growth. ACL is trading at an attractive 8x CY12ii EV/Ebitda (bottom-of-the-cycle Ebitda margin).

We recommend ADD on Grasim , primarily due to likely improvement in its 60% cement subsidiary, UltraTech Cement. Thus, we expect Grasim's consolidated earnings to improve in FY14. VSF prices could decline in the near term, owing to increased cotton supply in the current season, as estimated by the International Cotton Advisory Committee (ICAC). This would affect earnings and volume growth in the VSF division in FY12 and FY13. Grasim is trading at a reasonable 9.5x FY13ii P/E after the recent correction in its share price.

We retain BUY on India Cements (ICL), as the stock is available at a sharp discount to replacement cost. We expect ICL's cost of production to reduce in FY13/FY14 on: 1) improving efficiencies, as captive power capacity will account for 60% of the total power requirement in FY14, as against zero now; and 2) volume growth would outpace industry growth, due to stabilisation of the 1.5mtpa Rajasthan plant (60% subsidiary). ICL is trading at an attractive 5x FY13ii EV/Ebitda and EV/tonne of US$57/tonne.

We recommend ADD on Kesoram Industries (KIL), as its share price has corrected sharply and is available at a steep discount to replacement cost. The tyre industry increased tyre prices sharply to pass on the rise in rubber prices in 1QFY12. Thus, we expect KIL's tyre segment to report modest profit from 2HFY12. We expect cement margins to be volatile, as it is largely dependent on sustainability of pricing discipline in the southern region. Note that KIL's cement capacity is located in the south and 43% of its sales volume originates from here, with the balance coming from the western region. KIL is trading at a reasonable 5x FY13ii EV/Ebitda and EV/tonne of US$66 (adj. for the tyre segment).

We recommend ADD on Madras Cements (MCL), as the stock has corrected sharply and is available at a large discount to replacement cost. MCL's 5,000tpd clinker capacity recently commenced operations; hence, we expect the company's cement volumes to increase from FY13 vs. a decline in FY11. Power costs are likely to decline after the 45MW captive power plant commences operations in 2HFY12. MCL, a south-focused player, has benefited from strong pricing discipline in the southern region over the past two quarters; we expect margins to be volatile, owing to low utilisation among companies in the southern region and likely re-emergence of fight for market share when new producers begin production. MCL is trading at a reasonable FY13ii EV/Ebitda of 5.9x and EV/tonne of US$66.

We recommend BUY on Shree Cement (SCL), as the company would benefit significantly from likely improvement in utilisation in northern India (SCL derives ~70% of cement volume from this region). We expect cement volume growth to improve on the back of: i) reduction in fight for market share in the northern region; and ii) margin improvement, with likely increase in utilisation. We expect 22% Ebitda Cagr over FY11-14. We expect the power segment's Ebitda to improve with new capacity additions; however, per unit Ebitda may come under pressure, due to increase in competition. SCL is trading at an attractive FY13ii EV/Ebitda of 4.2x.

We recommend BUY on UltraTech Cement (UCL) on the back of likely demand revival in the eastern, northern and western regions (UCL derives 65% of cement volume from these regions). UCL is the largest cement company in India with a capacity of 49.5mtpa; its presence is skewed towards regions that are in a favourable position. UCL has huge spare capacity in the northern region; improvement in the region's utilisation should drive UCL's volume growth over the next two years. UCL is trading at an attractive FY13ii EV/Ebitda of 7.5x (bottom-of-the-cycle Ebitda margin).

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